Paul Winkler: All right. We’re back here. This is “The Investor Coaching Show,” and I’m Paul Winkler. So with questions that you might have, go to paul winkler.com/question or go to the website, paul winkler.com, and you just cruise over to the radio area there and you can ask a question there and we get that and we answer it here.
Free Money
Now, somebody emailed me a question and it was about going to one of these dinners. Who says there’s no such thing as a free lunch or a free dinner? You go to these dinners and you get pitched investment products.
In this particular case, it was a rather large bonus on an annuity. It was like a 47% bonus.
And then just the way this thing worked, and I got into it, and what I did is I looked at it and I said, “Oh boy.” He said, “Well, I’m too old for this.” And I said, “No you’re too smart for this.”
There’s no such thing as a free lunch is really what I tell people.
If somebody’s giving you some kind of a bonus, if they’ve got to give you a bonus to get you to put money with them, they’ve got to pay you to put money with them, then there might be something that you need to be a little bit leery about. Let’s just put it that way.
So in this particular case, it was a red large bonus. I went red. I actually found the product. I actually went out on the internet.
I was looking for somebody that was doing something like that. And number one, there is a product out there that does that, and I read the fine print. I took the bullet for you.
I went and read it. And basically it was talking about how you’ll have this bonus, you’ll have to hold it for 10 contract years, and then you’ll have to take lifetime income withdrawals.
So number one, the first catch is you’ve got to hold this contract for 10 full years. The other thing is it talks about higher surrender charges in the fine print as well. I always like to read the little letters in these contracts. And it talks about higher surrender charges, so if you want to get your money back out, yeah, good luck with that.
Then the other thing is how to actually get this bonus. So you put a $100,000 in there, it’s $147,000. You think of it that way and you go, “Wow, this is free money, right? Somebody’s going to give me free money.”
I’m like, “Yeah, not so fast.” Nobody gives you free anything. That’s not the way life works.
The Math on Annuities
But what I did is I decided to do a little bit of number crunching on this, and I was just reading the contract and what it said. Now, one of the things that it talks about here is you’ve got to take this lifetime income and it has these payments. So if you’re between the ages of, I’ll use 80 to 100. They have that.
If you’re between the ages of 80 to 100, they have a 6% payout and you think, “Oh wow, cool. I’m going to get this bonus and then hopefully that money will grow.” Then at some point in the future, once that money grows, it’s more than what I put in.
So it’s a bigger number, $100,000 is what I put in maybe, and then $147,000 is what’s growing. And then later on that’s going to be a larger amount of money and then they’re going to give me 6%. What’s not to like about that? That sounds really, really good.
Well, you actually have to be a little bit more suspicious and look at the math and see if that makes sense.
Well, what if we said, just to make the math easy for you, let’s say that I started with $67,000. Okay?
So I started with $67,000, and I put it in a regular annuity, just something I paid 4%. I’m just using that for both scenarios, I’m using a 4% return. How much would the $67,000 grow to?
If you do the math, it’s over a 10-year period, it grows to $100,000 at that rate. I ended up having an ending number of $100,000.
Well, what if I put it in this bonus annuity and they gave me a 47% bonus? My $67,000 jumps immediately to $98,000. Well, that’s nice. And then if it grows at that 4%, now it’s $145,000 versus 100.
Are Annuities a Good Deal?
So I look at that and go, “Whoa, wait a minute. That sounds pretty good, doesn’t it?”
Well, if you actually go out there, and I use a website out there where you can kind of play around with these numbers and it gives you actual contracts and what they actually pay out on our annuities, and it basically says your payment from that. Let’s say you put $67,000 and it grew to $100,000, and let’s say you gave them the total benefit of the doubt, and you started the contract at age 80 — you started the income at age 80.
Now technically they gave the range of 80 to 100, so any later age would’ve been better. So I’m really giving them the benefit of the doubt on this deal, okay.
So I do that. I take $100,000, and how much would my income be here? Maybe about $12,000 a year. Okay, so that would be the income from an annuity, a single life annuity for this $67,000 that grows to $112,000.
What would it be if you had that $98,000 — because you got the bonus — and it grew to $145,000, and they started giving you that 6% distribution, how much would you have? $8,700? You would literally have taken a haircut of about a third in this particular case. Is this a good deal or is this smoke and mirrors?
I’m telling you so much of this stuff. And we don’t know what the returns on the contract are going to be.
We have no idea what they’re going to return and how they’re going to limit the returns on the contract.
Matter of fact, there was a good article that I was looking at a little bit earlier. I was just looking around and it was FINRA — Financial Industry Regulatory Authority. These are the regulators of these people, and they have all kinds of warnings about this stuff. They really do.
They have a tremendous amount of information and warnings about the complicated risks, and you can actually look it up yourself. It’s “The Complicated Risks and Rewards of Indexed Annuities.” And they talk about how you have these indexes and they talk about how you can have guaranteed rates of return as low as one to 3%.
I used a higher rate of return — significantly higher — in my calculation. And you can end up with only 87.5% of the premium paid.
So you can have that happen. Participation rates of 75%. You’re going to actually only get 75% of the returns.
Risks and Rewards of Indexed Annuities
Okay, so what’s the catch? You need to ask that question when people are trying to sell you something that sounds too good to be true.
Advisors, I remember when I was one, man. When I was working for the big insurance companies and big investment firms, I was so skeptical. I couldn’t sell anything.
I was terrible at sales because I would be constantly asking questions and going, “This doesn’t make sense. This sounds too good to be true and I just don’t believe this kind of stuff.” I kiddingly say my mom passed through Missouri when she was pregnant because you got to show me.
Well, FINRA, the Financial Industry Regulatory Authority, has an article and it’s called “The Complicated Risks and Rewards of Indexed Annuities,” and that’s basically what we’re talking about. They get these bonuses on these things and it sounds really good. Well, they said they’re complex financial instruments.
Retirement experts warn that such annuities include a number of features that may result in lower returns than the investor might expect.
Go figure. Tie it to the S&P 500 and the return and the products may be higher or lower than the guaranteed rate of return with unconventional fixed annuities. So you got a little bit of a wild card there and it says, “Guaranteed return usually ranges from 1 to 3% or at least 87.5% of the premium paid.”
The other thing they said in there was, “Participation rates might be 75%.” So you’re only going to get 75% of the gains of the index and then you have spread margins and those types of things.
Now, it talks about interest caps. Here’s where I’m going to just hit a couple of numbers. It says, “Meanwhile, essentially this means that during bull markets, investors won’t see their returns go sky-high.” That’s what it says here.
It says if the index rises 12%, but an investor’s EIA, indexed annuity, has a cap of 7%, the return will be limited to 7%. Now, some people look at that and go, “12% is really good.” Do you know that over the past 50 years, the S&P 500 has exceeded that and many years exceeded that by a lot, 28 times?
So you look at that and go, “Whoa,” and now you don’t even get dividends. That’s another part of the return that goes away.
So you take caps, you take participation rates and after a while you go, “Gosh, who’s winning on this one? Me or the insurance company?” And the insurance company’s got a bigger building than you’ve got probably, I’m guessing.
It pays to have somebody on your side, in my humble opinion, representing you rather than the investment companies. That’s us, at paulwinkler.com.
Advisory services offered through Paul Winkler, Inc an SEC registered investment advisor. The opinions voiced and information provided in this material are for general informational purposes only and not intended to provide specific advice or recommendations for any individual. To determine what investments are appropriate for you, please consult with a financial advisor. PWI does not provide tax or legal advice. Please consult your tax or legal advisor regarding your particular situation.
